I don’t claim to be an expert on the crypto space and don’t really understand it. Yes, blockchain might prove useful, but I fail to understand why a crypto asset should be worth billions because of the usefulness of blockchain. Second, I disagree that cryptos are a hedge against inflation. I also disagree with the notion that cryptos will replace currencies, or that they are an alternative to Central Banks.
However irrespective of what one believes, what is important for investors at the moment is that the regulatory cloud we have mentioned in the past is just beginning. And the regulatory assault on the crypto space is coming from multiple sides.
SEC chairman Garry Gensler in a recent House committee hearing, made it clear that there is no investor protection regime for the crypto space at the moment, implying the need for regulation. He also mentioned regulating exchanges and that he was concerned about price manipulation. Coinbase, for example, is registered in most states as a money transmitter, not as an exchange.
Meanwhile in China, where banks have been banned from getting involved in crypto for several years now, is also preparing more regulatory scrutiny. As a result, two miners said they will cease operations in China citing “regulatory risks”.
Finally, the Biden administration’s tax enforcement plan released Thursday calls for transactions of more than $10,000 to be reported to the IRS. This might lead to many investors liquidating their holdings before any such plan becomes law.
We don’t really have a crypto strategy and as a general rule of thumb don’t get involved in the space. However irrespective of the different opinions about cryptos, investors who venture in the space need to be aware of the regulatory risks. These might include, but not limited to, tax liability risks, regulatory scrutiny of exchanges, clarity in the ownership structure of many cryptos, and investor protection regulations.
Please note that the appeal of the crypto space has been that it was a non-regulated and decentralized investment. However, if regulators enforce the same regulatory scrutiny on the crypto space as in other investments, that could alter the appeal of the space, and the value of cryptos as perceived by participants in the space.
Inflation scares have been around for years. In fact, there has never been a moment over the past 20 years or so that market pundits have not reminded us about the dangers of inflation, as a result of Central Bank policies.
The word on the street over the past several weeks has been that inflation is roaring back. As a result, the market will correct because of higher interest rates ahead (they say). In fact, as Bloomberg reported, inflation expectations are at 16-year highs.
So, let us talk about inflation. Yes, inflation this year and perhaps next year will be elevated, but from the very subdued levels of 2020 (the Covid year). Also, the last time inflation was above 4% was towards the end of the previous financial crisis. As a rule of thumb, inflation tends to spike when exiting a recession.
However insofar as interest rates are concerned, it took the Fed many years to feel comfortable raising rates, and even then, at an anaemic rate of 2.5% in 2019. But raising rates back then almost threw the US economy into recession, that forced the Fed to take everything and introduce extraordinary accommodation actions. This even before COVID.
Yes, bond yields have moved up a bit over the past several months, but this is more of a reflex reaction of markets. I don’t think it’s a sign of long-term inflation returning, or that yields will be spiking a lot higher, thus prompting investors to sell equities and move to treasuries.
The Fed will not make the same mistake in made in 2019, raising rates for the sake of raising them, that almost threw the US economy in recession. Also, the fact that the Fed continues to purchase assets, will deter yields from moving much higher.
And yes, real rates will continue to be negative, perhaps for years. However, this is also not a reason for Central Banks to raise rates and threw economies into recession. The extraordinary accommodation Central Banks are providing will be with us for a very long time to come.
The bottom line is that I would not worry much about inflation. As the Fed and ECB have said, inflation will be transitory. Longer term, demographics and technology are still deflationary forces, and will most likely overtake inflationary forces. So, while markets might correct as inflation ticks up a bit, chances are a correction will be another dip buying opportunity.
The chart below from Goldman Sachs research shows that short interest for the S&P 500 Index are at all-time lows. In other words, those that are betting on the index falling, are a very rare breed.
Many years ago, this chart would have been interpreted as a contrarian indicator. The logic being that, with record bullishness everywhere, it’s probably time to sell. However, this time around I think we have to take this data at face value. And that is none other than a bullish indication.
The reason why short interest is probably so low, is not for a lack of institutional investors who think that markets cannot go down, but probably because they have been squeezed out of their positions in attempting to do so.
With liquidity continuously coming into the market from all sides (Central banks and physical spending), it is no wonder equities keep going up.
Also keep in mind that bonds, especially sovereign debt, is not an option for most institutional investors. If institutions want yield, they will not find it in debt, unless they want to take on a lot of risk. And when searching for yield, equities are probably the route at the current time.
The bottom line is that all roads continue to lead to equities. The record low short interest is probably a testimony to this. And contrary to the past, a record short interest currently cannot be interpreted as a contrary indicator, but has to be interpreted at face value, that being that is still a very bullish market.
While major indices don’t show it, and most investors don’t see it, many parts of the technology sector are crashing. And by that, I mean that many stocks have been falling for months now, even if this internal technology correction has not affected the major indices (yet).
Almost all EV stocks are way off their highs, perhaps with TESLA having corrected the least. Even highly covered and talked about stocks like Quantum Scape, that is developing a next generation battery for EV cars has gone from about $130 to $28. AMD had its best quarter ever and has fallen about 15% from its last report. Even Apple has not been able to rally, even if its quarter blew the consensus away. ZM has fallen over 50% from its highs, and DOCU which reached almost $300 a share last year, is trading at around $190.
In fact, perhaps a better illustration of what has been happening is the ARKK EFT, that has many of the high flying names mentioned above.
The ARKK ETF has lost about 1/3 of its value from its high, and down about 20% year to date.
The question is, is this technology correction over and might many of these stocks be a buy?
My answer is no. Even after a huge correction, most of these names are still not investable. The reason being valuation concerns. In my book, stocks like AMD and ZM would have to fall by an additional 60% or so, before valuations make any sense.
The next question is, will the correction in technology bring the entire market down? The answer is we don’t know, but so far, the major indices are not showing signs of stress (yet).
However, if stocks like Apple make a serious correction, then all bets are off. The market will probably correct by a lot. But in order for that to happen, we would have to see a lot of money exiting this market, especially from passive funds.
And what might be the reason for a rush to the exists from investors? Two things come to mind these days, inflation and an increase in capital gain taxes in the US.
However, don’t blame the correction on neither of these issues. At its core, the correction we are seeing in the technology space has everything to do with valuations and investors getting carried away than anything else.